June 16th, 2006

Jim Cramer and Timing the Market

Our friend, Jim Cramer, just last week said that he doesn’t want to hear talk about a “bear market” because he just doesn’t believe there is such a thing or in timing the market. And yet hasn’t he before bragged about having made his reputation and his hedge fund’s fortunes by liquidating most of his holdings and moving into cash in 1999-2000, just prior to the bursting of the tech bubble. I’d call that “market timing”, Jim, but what do you call it? You can’t have it both ways.

With the precipitous correction in the major indexes over the past several weeks, it’s to be expected that many people from Wall Street and in the business media trot out the old debate (at least, I call it a debate …. many of them believe the case was made settled long ago in 1973 when Burton Malkiel wrote his treatise “A Random Walk Down Wall Street”) as to whether or not the stock market can be “timed”. According to Investopedia, the definition of “market timing” is “The act of attempting to predict the future direction of the market, typically through the use of technical indicators or economic data.” I much prefer thinking it’s a strategy for portfolio management taking into primary consideration the overall market’s immediate health.

It’s interesting that while Wall Street types say that anywhere from 50-70% of an individual stocks movement is dependent on and correlated with the movement of the market (the remainder being determined by factors specific to the stock and its industry group), they don’t believe individual investors should manage their portfolios with market timing considerations. They much prefer that have investors continual buying stocks (and thereby maintaining
a commission revenues stream!) without consideration to whether the market is trending down (or up) under alternative strategies like buy- and-hold or dollar-cost averaging.

If you’ve read the “about me” in the panel to the right, you know that I’ve been at this game for nearly 40 years yet it’s only recently, since I started doing it full time, that I began seeing the forest (the market) rather than only focusing on the “trees” (individual stocks). It’s only after I, like many others, got burned during 2001-03 that I’ve begun incorporating the state of the market ahead of individual stock charts. I can’t believe that it was only recently (thankfully, before the beginning of the last bull-leg began on March 11, 2003) that I learned some compelling market timing facts. Consider the following:

  • “According to the Stock Trader’s Almanac 2003, from 1950 to 2001, an initial investment of $10,000 produced a total loss of $77 for the entire May-October period. This compares with a gain of $457,103 when the investor was investing in the November-April period.”
  • “Using the MACD’s buy signal newar November and sell signal near April, you would have realized a gain of $1,199,247 for the DJIA from November through May, in the same period 1950-2001 while the May through November showed a loss of $5977.”
  • “In back testing for the 38-year period 1964 through 2002, the strategy would have produced a total compounded return of 15,172%, using an index fund on the DJIA, compared to 4577% for buy-and-hold. Converted to dollars, it would have turned a $100,000 investment in 1964 into $15,272,750 in 2002, compared to $4,677,170 for the buy-and-hold investor.
  • Formula Research (August 21, 2001) tested the September avoidance strategy from 1950-2001, This strategy with an initial $10,000 stake would have returned an annualized return of 13.4%, worth $5.6 million. During this same period buy-and-hold would have generated a return of 12.5% and earned $3.9 million….Selling short in September would have increased the returns (for the period 1900-2000 starting with $100) to $644,467 compared to $20,699 for buy-and-hold
  • From 1950-1995, the buy-and-hold strategy, this often-touted simple no-decision strategy had an average annual return of 8.4 % that turned a $10,000 initial investment into $372,388 with a maximum drawdown (or maximum loss) of 41.3%….Now compare those results with the simple strategy of investing only during the best performing two presidential cycle years (the pre-election and election years) and remaining in cash for the other two years (midterm election and post election years). This strategy has an average annual return of 10%. But over 45 years, that incremental differenc resulted in the growth of the $10,000 investment to $733,605, a 197% improvement over buy-and-hold.

I obtained these, and many more facts supporting a market timing strategy, from All About Market Timing by Leslie N. Masonson (available from Amazon by clicking the button at the right).

Taking all this into consideration, where are we now? Being hit with a double whammy, that’s where. Not only are we in the “don’t buy, don’t buy” months of the year but 2006 is also a mid-term election year. Match that up with the belief by some that we’re still in a secular bear market and that the market’s valuations (as measured by the P/E for the S&P 500, that is) is still too high and this to me looks like a reason for having a large percentage of your portfolio, if not all, in cash (money market funds).

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  • Anonymous

    Very interesting piece, thanks for that. I wonder why most of the stats I’ve seen of this nature are about the Dow 30? Why not a broader index? Makes it much less credible to be about a narrow, manufactured index…
    Just wondering.

  • James F.

    It provides credence to the term ‘Sell in May and go away’ doesn’t it. Or better yet, ‘Short in May and stick around’…

  • bodotdot

    You mentioned an “initial investment of $10,000” from 1950-2001. An investment in what? Index funds didn’t exist in the 50’s and 60’s. Are they referring to weighted investments in each of the 30 Dow stocks? Wouldn’t moving all of those investments in and out of each stock twice every year incur quite a boatload of fees and taxes? You go on to mention “an index fund on the DJIA.” Which specific index? Would the after-tax results of such a “simple” strategy still beat a buy-and-hold “Total Stock Market Index” strategy?
    Also just wondering.